Anticipating delinquent revenue distributions from the state and county, Evanston aldermen this week authorized the city manager to sign an agreement with Chase Bank to access a $10 million line of credit in order to have sufficient cash for daily operations.

While the credit line would only be used if needed due to late payments, city officials indicated their certainty that delinquent payments from the state and county are a foregone conclusion.

According to a staff memo, the city has for some time experienced “serious disbursement delays” in state income tax funds. That same memo states that Cook County has been “extremely late” in sending out tax bills this year, meaning Evanston would not receive the second installment of 2009 property tax revenue until mid-December. Plus, the county has pushed back the due date on the first installment of 2010 property tax payments to April 1, 2011.

The memo further states that the city has a $14 million debt service payment due by Dec. 1 of this year and a $2.5 million debt service payment due by Jan. 1. Additionally, the city averages $8 million in monthly payroll and accounts payouts, but only takes in monthly estimated revenues of $7 million.

Tax-exempt bonds are yielding more than Treasuries for the first time since the financial crisis, a relationship that history shows doesn’t last, especially as the Federal Reserve kindles inflation expectations.

Investors buying AAA municipal general obligation bonds due in two years get a yield equal to 119 percent of similar- maturity Treasuries, Bloomberg Fair Market Value data show. A ratio above 100 percent means those in the 38.3 percent federal tax bracket get higher yields plus tax-sheltered income. Before the credit crisis in 2008, that happened twice in the 20 years for shorter-maturity debt.

The combination of worsening state and local finances and a surge in sales that included $15.5 billion of offerings last week, the most in more than seven years, has pushed tax-exempt bond payouts above Treasuries. Muni rates rose faster even as yields on 10-year U.S. notes posted the biggest two-week increase in almost a year on speculation the Fed will avoid deflation by purchasing $600 billion of government debt.

“The value pendulum has swung from Treasuries to munis,” said Jonathan Lewis , founding principal of New York-based Samson Capital Advisors LLC, which manages $7.3 billion. “Municipals are a good place to park your money and get a yield advantage that typically wouldn’t be there.”
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Alarm Bells

Harrisburg, the capital of Pennsylvania, is struggling to avoid bankruptcy, and a South Carolina toll road defaulted on its debt. Meredith Whitney , the banking analyst who correctly predicted Citigroup Inc.’s dividend cut in 2008, said in September that the U.S. government will face pressure to bail out struggling states in the next 12 months, joining investor Warren Buffett in raising the alarm about the potential for widespread defaults in the $2.8 trillion municipal bond market.

Investors withdrew $3 billion from open-end municipal bond mutual funds in the week ended Nov. 17, the most in almost 19 years, according to Lipper FMI.

“It’s become a negative-feedback loop,” Thomas Metzold , co-director of municipal investments at Boston-based Eaton Vance Corp., said last week. “Funds have to sell bonds to meet redemptions, putting pressure on prices, causing more redemptions.”

Money managers point to a strengthening economy and recovering tax revenue as signs that municipal yields will fall below Treasuries. California, Texas, Florida and New York, the four biggest states, all added jobs last month for the first time since May.

Concerns Overstated

The gains could help shrink budget deficits that the Center on Budget and Policy Priorities says will likely total $140 billion in fiscal 2012, as new jobholders boost income- and sales-tax collections. States’ tax revenue grew about 6 percent in the three months ended on Sept. 30, the third consecutive increase, Goldman Sachs Group Inc. said Nov. 19.

Concerns about borrowers missing debt payments have been overstated, according to a report by Fitch Ratings on Nov. 16. Investment-grade municipal default rates were as low as 0.04 percent over the past 10 years, the report said.

“While the incidence of default may increase from exceedingly low historical levels, defaults will continue to be isolated situations,” the report said. “There is a long record of governments making difficult choices to maintain budget balance while making full and timely debt service payments even in very stressful financial situations.”

The city of Vallejo, California, proposed paying some creditors as little as 5 percent of what they are owed, making it the first general municipality that would fail to fully repay its debts in bankruptcy.

General unsecured creditors would collect 5 percent to 20 percent of their claims under the plan of adjustment filed late yesterday in U.S. Bankruptcy Court in Sacramento, the state capital.

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Policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers.

Unlike cities, the states are barred from seeking protection in federal bankruptcy court. Any effort to change that status would have to clear high constitutional hurdles because the states are considered sovereign.

But proponents say some states are so burdened that the only feasible way out may be bankruptcy, giving Illinois, for example, the opportunity to do what General Motors did with the federal government’s aid.

Good luck with that.

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How safe are your municipal bonds? That depends on which ones you own. “Muni bond defaults are far more likely to default than at any time in recent history,” says bond expert Alex Anderson, vice president of Envision Capital Management. Most of them will pay, but you have to buy them right.

The danger has been hiding in plain sight since early in the financial collapse, and I wrote about the risks myself back in May. This week, financial analyst Meredith Whitney, the first person to out Citigroup as a zombie bank before the market collapse, went public with a new warning: expect 50 to 100 “sizable” muni bond defaults — hundreds of billions of dollars worth. “I think next to housing this is the single most important issue in the United States, and certainly the largest threat to the U.S economy,” she told 60 Minutes.
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[I'm just going to put the bullet points]
1. Buy pre-refunded muni bonds.

A spate of recent articles regarding the fiscal situation of states and localities have created the misguided impression that drastic and immediate measures are needed to avoid an imminent fiscal meltdown, according to a major new report from the Center on Budget and Policy Priorities. These articles mistakenly lump together states’ and localities’ current, largely recession-related fiscal problems with longer-term issues relating to bond indebtedness, pension obligations, and retiree health costs.
Most states are projecting large operating deficits for fiscal year 2012, as revenues remain well below pre-recession levels even as the economic downturn has increased the need for public services. States are required by law to close these deficits before the start of the fiscal year, just as they have done in each of the past three years. In contrast, states have several decades to address the above longer-term issues, whose size recent articles have tended to exaggerate.
“Overheated claims about state and local budget problems not only are inaccurate, but also could lead policymakers to take unwise steps such as allowing states to declare bankruptcy or forcing them to change the way they report their pension liabilities as a condition for issuing tax exempt bonds,” said Iris J. Lav, senior advisor to the Center and the report’s lead author.
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Claims that states and localities have $3 trillion in unfunded pension liabilities that may drive them into bankruptcy are similarly exaggerated, according to the report.
The oft-cited $3 trillion figure is based on valuing future liabilities as if investments in pension trust funds will earn no more than “riskless” investments such as Treasury bonds. In reality, however, state pension trust funds are invested a diverse mix of stocks, bonds, and other instruments and have earned a much higher return in recent decades than riskless investments. If one follows accepted state and local accounting rules and calculates pension liabilities using the historical return on plans’ assets, the unfunded liability stands at a more manageable $700 billion. This, and not the amount derived from the riskless rate, is closer to the amount of funds states and localities are likely to actually have to contribute to make their pension funds whole.
In most states, a modest increase in funding and/or changes to pension eligibility and benefits should be sufficient to remedy underfunding, the report explains. The small number of states that have skipped contributions or increased benefits without corresponding funding likely will have to make larger changes. But states and localities have the next 30 years in which to remedy any pension shortfalls; they generally should avoid increasing pension contributions as long as the economy remains weak and they are struggling to provide basic services.

Oh really? How did that work out for Prichard and how is that going to work out for Detroit? You can't count on that tax base existing 30 years from now.